• Choose a category
• All
• Classic-Fiction

Inspired to take action after a 1730 fire destroyed the shops on Fishbourn’s wharf in Philadelphia, Benjamin Franklin wrote a guide on “different accidents and carelessnesses by which houses are set on fire . . . and means of avoiding them.”23 Shortly thereafter, Benjamin Franklin started Union Fire Company, the first volunteer fire department in North America. Even more important to the future success of the as-yet-unborn Warren Buffett and Charlie Munger, Franklin also started the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire, the first successful (Charles Town’s earlier effort was unsuccessful) fire insurance organization in North America. The first board meeting was held in 1752, the year the colonies switched from the Julian calendar to the Gregorian calendar, two years before the British colonies sent representatives to the Albany Congress, and 24 years before those colonies declared independence from Britain. Franklin noted that when it came to fires: “An ounce of prevention is worth a pound of cure,”24 but for what one cannot prevent, insurance helps provide the pound of cure.

Run properly, underwriting risk is a money-making machine that makes a commercial bank look like a child’s piggy bank in comparison. A successful insurance operation generates float, premiums received before losses are paid—sometimes years or decades before losses, if any, are paid. An insurance company does not technically own its float, called reserves, but it has the use of the reserves for investment purposes. A rising tide lifts all boats, and an increasing stream of well-invested float lifts all returns.

Americans love to buy insurance. My cyber-friend, Andrew Tobias, wrote a classic book on the insurance industry, The Invisible Bankers, more than a quarter of a century ago. Some regulations have changed, but the fundamental principles of making money in the insurance business have remained the same.Tobias cites a Playboy survey in which 91 percent of the men thought a car is a necessity—and it is difficult to use that necessity without car insurance. 88 percent of the men thought health insurance was a necessity. Even though only 60 percent of the men surveyed were married, 79 percent of the men responding thought that life insurance was a necessity, not a luxury. Only 16 percent of the men thought that dining out every week was a necessity.25

So the question isn’t whether or not Americans will buy insurance, but rather, how much will they buy and from whom?

The competence of the insurer is crucial, because Mr. Market’s manic depressive cousin prices insurance risk. The magic trick in the insurance business is to avoid volume just for the sake of volume.

Auditors do not seem competent to evaluate reported reserves, since anyone can create huge reserves by underwriting bad business. How did that work out for MBIA and Ambac? The rating agencies seem even worse than the auditors. When rating agencies told Berkshire Hathaway they liked to see an increasing revenue stream in AAA insurance companies, Warren told me he said he would never let revenues be his target. Anyone can increase revenues by underwriting risk at the wrong price. In a shareholder letter, he wrote:

Where “earnings” can be created by the stroke of a pen, the dishonest will gather.26

Warren’s insurance businesses only underwrite insurance risks when market prices are favorable. Insurance success depends on pricing premiums so that premiums exceed losses and expenses. When prices aren’t favorable, Berkshire Hathaway ignores Mr. Market’s cousin. But when it can underwrite risk at premium prices, Berkshire Hathaway’s insurance businesses participate massively.

Simonides, a Greek poet and philosopher, was among a handful of survivors after an earthquake destroyed the great hall of a palace where he attended a party. The crushed victims’ bodies were so badly disfigured that grieving relatives could not identify